There are many reasons a business can suffer cash flow problems. Any of the following symptoms can indicate that a business is experiencing cash flow problems:
- Up to overdraft limit
- Stretching to pay salaries each month
- Trade creditor arrears
- Taxation arrears
- Rent arrears
- Negative or no working capital ‘buffer’
- Lack of funds for remedial action
- Lack of profitability
To address these problems, there are 4 main areas a business can focus on. Whilst reviewing these areas it’s necessary to review the related business’ processes and activities which will help to improve and better manage cash flow. The four areas that businesses should focus on are:
- Profit & Expenses
The most important thing all businesses need to do is forecast their cash flow, specifically a rolling 13-week forecast. Performing a forecast is the most important tools in managing your finances.
Forecasting reveals important details including how large the shortfall in cash flow is and highlighting the levers that the business can focus on to improve its cash flow.
Without having some sort of understanding of what those levers are then it makes it very difficult to begin to properly manage a business’ cash flow.
Profit & Expenses
One sure thing about generating cash flow is that you need to generate profit. There are two elements to increasing profit, one is increasing sales and the other is to reduce expenses.
When analysing a business’ sales, it is important to ask;
- What are the business’ opportunities to sell to new clients and how effective is the business’ marketing plan to take advantage of these opportunities?
- How effective is the business’ sales process and are you converting qualified leads into new customers?
In regards to existing customers, it is important to ask;
- How hard is the business working those existing relationships?
- Are there opportunities to increase the average sale or cross-sell?
In the right circumstances, businesses can even increase prices for certain customers.
Tackling these questions at the outset of reviewing their cash flow can help business to create new customer opportunities and leverage existing relationships to improve their cash flow.
As well as looking to increase sales it’s critical to review all expenses in a business. In this regard it is important to ask;
- Are there discretionary expenses?
- Are there expenses that the business should be putting out to some sort of competitive pricing or tendering?
- Is there waste happening within the business i.e. is your business engaging in activities which are not delivering your value proposition to your target customer? Essentially reviewing whether the business has within it people or activities that really aren’t adding any value to the work they conduct with their customers could reduce waste.
Another source of cash flow is capital of which there are two arms. The first is working capital and the second is fixed capital or plant and equipment.
To improve a business’ cash flow whilst considering Working Capital a business may explore
- How can the business improve their debtor collection?
- Are there opportunities to reduce stock or inventory in the business including moving on slow moving or obsolete stock that is tying up unnecessary cash?
- Can we look at our ordering processes for stock?
- Can we talk to our creditors about moving payment terms from 14 to 30 to 60 days?
The second arm of capital is plant and equipment. Issues can arise because often businesses make decisions to buy without looking at opportunities to lease or hire that equipment. Buying equipment is a common oversight which can unnecessarily tie up capital.
Businesses can also investigate other opportunities to divest plant and equipment. There may possibly be a piece of equipment the business has been carrying that’s no longer required. Where this equipment is surplus to capacity, the business should look at how they may be able to divest the plant and equipment to create another source of increased cash flow.
The final area to focus on is finance. Often owners don’t realise how much they’re taking out of their business. Like any part of the business, the payment of those owner distributions needs to be reviewed to ensure they are sustainable.
An essential element of finance is debt, it is important to ask;
- Is the business properly structured in terms of the debt?
- Is the amortisation period for loans and hire purchase too aggressive?
- Is the interest rate reasonable?
- Is there unused security?
If there is security that the business isn’t using that the business can tap into to, the business can broaden its source of cash flow. Businesses should also explore debtor finance or inventory floor plan that may open up new opportunities to generate cash flow.
If a business ticks these boxes working through forecasting and then focusing on how to improve profit and working capital management and then looking at their finance options, it will help them better manage their cash flow
About the Author: Tony Monisse
Tony Monisse founded Brentnalls WA in 1993 after 14 years with the Big 4 accounting firms in audit and income tax, including a two year secondment to London.
He provides business advice to growing private companies on a wide variety of matters, including:
- strategy and financial management
- tax planning
- restructure of business, including acquisitions and
- sale of business
- asset protection
His passion is the effective integration of strategy and financial management and to this end he has developed tools and process that facilitate this integration, including business modelling, target setting and rolling cashflow forecasts.
Tony facilitates advisory boards for a number of clients and is a presenter for the Brentnalls WA Business Getting Results Forum and Business Growth Network. He is a member of ‘The Executive Connection’ and former Chairman of the Brentnalls National Affiliation of Accounting Firms.